The economic benefit from lifting lockdowns may depend significantly on the lockdown strategies of other regions and countries due to supply chain links. This column analyses the importance of supply chain links in this context by conducting a simulation analysis applying rich firm-level data from Japan to an agent-based model of production. It finds that the production of two regions can attain greater recovery by lifting their lockdowns together when they are closely linked through supply chains in either direction. These results point to the need for policy coordination among regions when regional governments impose or lift lockdowns.
COVID-19, the novel coronavirus (SARS-CoV-2) disease, has been spreading worldwide. To prevent its spread, many cities, regions, and countries were or have been ‘locked down’, shutting down or stifling economic and social activities. On 18 April 2020, in 158 out of a total of 181 countries, business in some sectors in some or all cities were required to close temporarily or implement working from home. Although some countries later lifted their lockdowns, as of 8 February 2021, 106 of the 158 countries have maintained or reimposed lockdowns that had negative effects on companies because of multiple waves of the pandemic (Hale et al. 2020).
Closing workplaces shrinks the economic output of locked-down regions. The negative economic effect of a lockdown in one region may diffuse through supply chains (i.e. supplier-client relationships of firms) to other regions that are not necessarily locked down. When a firm is closed by a lockdown strategy, the productivity of its client firms is likely to suffer because of the lack of supply of intermediate goods and services. Suppliers of the closed firm are also likely to see reduced production because of a shortage of demand.
Many studies have empirically confirmed the propagation of economic shocks through supply chains, particularly shocks originating from natural disasters (Barrot and Sauvagnat 2016, Boehm at al. 2019, Carvalho et al. 2021, Inoue and Todo 2019, Kashiwagi at al. 2021). Some examine the diffusion of COVID-19-related lockdown effects on production across regions and countries and estimate the total effect using input-output (IO) linkages at the country-sector level (Bonadio et al. 2020, Guan et al. 2020, McCann and Myers 2020, McKibbin and Fernando 2020) and using supply chains at the firm level (Inoue and Todo 2020).
However, one important aspect not fully examined in the literature is the interaction of lockdown strategies of different regions and countries and the resulting need for policy coordination. The importance of such interactions is motivated by the experience of Sweden. Sweden, unlike other European countries, did not impose a strict lockdown in 2020 in an attempt to minimise the economic effects of the pandemic. However, it experienced a 7.4% reduction in GDP in the second quarter of 2020 compared with the previous year. This reduced production in Sweden is comparable to those in neighbouring countries that imposed lockdowns – e.g. -6.2% for Finland and -4.6% for Norway (Eurostat) – possibly because of propagation of negative effects from locked-down countries to Sweden through economic networks. This anecdote calls for an examination of the interactions of the economic effects of lockdown strategies.
For this purpose, in Inoue et al. (2021), we conduct a simulation analysis applying actual supply-chain data of 1.6 million firms and experiences of lockdowns in Japan to an agent-based model of production. We first confirm whether our model and data can replicate the actual reduction in production caused by the lockdown of Japan during the state of emergency in April and May 2020. Figure 1 indicates that our prediction of daily value added of Japan during its lockdown represented by the green line fits the monthly value added calculated by the actual economic index (Indices of All Industry Activity) and is well represented by the red line in the sense that the total predicted loss is equivalent to the actual loss.
We then analyse the impact that supply-chain links of a prefecture in Japan may have on the economic recovery from lifting its lockdown using two sets of simulations. In the first, we assume that one prefecture lifts its lockdown when all other prefectures remain locked down and examine the correlation between its supply-chain characteristics and economic recovery. Next, our simulation investigates how the characteristics of the supply-chain links between two prefectures affect their economic recovery when they simultaneously lift their lockdowns.
Our main findings are as follows. First, the production of two regions can attain greater recovery by lifting their lockdowns together when they are closely linked through supply chains in either direction. Besides the total number of links between the two regions, the intensity of such links compared with links with other regions is also important.
Second, a region that is more isolated in the network or that encapsulates more supply-chain loops within the region is likely to see greater recovery in production by lifting its lockdown. Similarly, the production of the two regions can recover more by lifting their lockdowns together when their inter-regional links have more loops. These results imply that the positive economic effect of lifting a lockdown circulates and is intensified in supply-chain loops. Supply-chain loops exist between two regions when, for example, downstream goods produced in a region (e.g. machinery) are used as inputs by upstream suppliers in the other, while the suppliers provide parts and components (e.g. semiconductor) to the downstream manufacturers.
Finally, the recovery of a region after a lockdown is greater when suppliers that are still locked down can be replaced by others within the region or in other regions without a lockdown in place. The role of the substitutability of suppliers in mitigating the propagation effect through supply chains has been empirically found in the literature (Barrot and Sauvagnat 2016, Inoue and Todo 2019, Kashiwagi et al. 2021). A practical implication from this finding is that firms should be linked with geographically diverse suppliers so that suppliers in a locked-down region can be replaced by those in other regions without a lockdown.
All these results point to the need for policy coordination among regions when regional governments impose or lift lockdowns. Although this study uses the inter-firm supply chains within a country and considers the economic effect of prefecture-level lockdowns, our results can be applied to the effect of country-level lockdowns that are propagating through international supply chains. For example, many suppliers of German firms are located in Eastern Europe and many suppliers of US firms are in Mexico. Our results thus suggest that the economic gains of Eastern Europe and Mexico from lifting their lockdowns is minimal if Germany and the US, respectively, remain locked down.
This article first appeared on www.VoxEU.org on March 25, 2021. Reproduced with permission.